The Link with Technology Transfers and Spillovers

International production and distribution networks provide various opportunities for multinational enterprises (MNEs) and local firms in developing countries to compete and cooperate with each other. Such interactions between MNEs and local firms are much more varied and intense than in a world with relatively simple North-South industrial divisions of labor. This implies that the nature of technology transfers and spillovers has evolved in the enhanced economic dynamism.

In comparison with the relocation of whole operations to least developed countries (LDCs), a MNE has a greater degree of freedom in how to cut out production blocks, which in turn yields greater flexibility in the location pattern. This means that a MNE can relocate some activities to LDCs with much smaller-commitments than in the case of relocating all activities. The consequence is that some production processes actually move to LDCs with technology advantages. From the viewpoint of hosting LDCs, such transfers require less policy than in the case of the relocation of the entire industry in the form of import-substituting foreign direct investment (FDI).

The physical movement of technology and managerial know-how to LDCs would provide more opportunities for local firms and entrepreneurs to enjoy technology transfers or spillovers. However, there is a potential difficulty that comes with these slices of value chains. Particularly at the early stage of development, fragmented production blocks do not typically engage in transactions with neighboring firms, which limits the linkage channel of technology transfers and spillovers to a particular firm. In addition, technology absorptive capacity is one of the crucial determinants for what sort of production processes will be located in LDCs, whether vertical linkage is developed, and whether technological spillovers occur. LDCs at the initial stage of industrialization typically suffer from low technology absorptive capacity.

Once LDCs reach the stage of industrial agglomeration, the perspective of technology transfers and spillovers is drastically improved. In industrial agglomeration, vertical division of labor by means of inter-firm transactions is actively conducted. Initially, such transactions tend to be among upstream and downstream MNEs. However, under severe competitive pressure, MNEs start seeking local firms to transfer technologies to local firms and entrepreneurs in order to obtain a supply of parts and components at satisfactory prices, quality, and delivery timing. Technology absorptive capacity of local firms and entrepreneurs again becomes an important determinant of the extent of technology transfers and spillovers. A key difference from traditional import substitution with heavy trade protection is the competitive pressure from international markets, which forces efficiency in MNE operations.

The spatial structure of production networks provides an important geographical consideration regarding technology transfers and spillovers. At least in the case of machinery industries with major just-in-time systems, inter-firm transactions almost always occur in geographical proximity. When a novice local firm enters international production networks, it most often occurs as a first layer transaction. This coincides with the geographical extent to which human resources can travel daily. Cross-border inter-firm transactions by local firms, such as transactions at the second or third layer of production, are rare except in cases where the firm has already established a strong reputation. Layer of production refers to different stages or phases of production.

In industries other than machinery, some adjustments are necessary. In the garment industry, for example, the speed and frequency of transactions are typically slower that in the machinery industry, and thus longer distance transactions between MNEs and local firms may be possible. In the software industry, the geographical distance in transactions may be less important, although credibility remains important. In both cases, technological links with MNEs are crucial to the quality of work.

3.1 New Development Strategies and Technology Transfers and Spillovers

The formation of international production and distribution networks in East Asia induces a fundamental revision of development strategies for LDCs. New development strategies claim that participation in international production and distribution networks is the key to accelerating economic development in an era of globalization.

The development of international production and distribution networks in East Asia also presents a new perspective on technology transfers and spillovers. Hosting FDI generates both positive and negative effects on local firms and entrepreneurs. Negative effects stem from enhanced competition in local markets for products and labor, and technological dominance by MNEs may adversely affect the performance of local firms. On the other hand, positive effects include easier access to technology and managerial know-how for local firms and entrepreneurs. Technology transfers or spillovers may occur in the form of imitation or reverse technology, spin-off of engineers, and most notably vertical links to upstream and downstream MNEs.

A traditional development strategy known as import-substituting FDI seeks to establish vertical links between local firms and MNEs, and leverages those links to explore the possibility of technologically upgrading local firms and entrepreneurs. Such attempts often fail because the size of the local market is small and compensating incentives for MNEs such as import restrictions degrade the competitive environment. Under discretionary incentive schemes, MNEs typically have a weak incentive to make technology transfers to local firms and entrepreneurs.

Another development strategy that utilizes export-oriented FDI and does not provide a notable increase in technology transfers and spillovers insofar as the activities of MNEs are geographically segregated in narrow export processing zones (EPZs). MNEs in EPZs are exposed to international competition and pursue maximum efficiency. In this situation, the value-added slices that MNEs bring in are often very thin and limited to purely labor-intensive activities, and the enclave nature of EPZs becomes a serious obstacle to technology transfers and spillovers.

The concept of four layers of transactions has a profound implication in the context of East Asia. Developing countries at the early phase of economic development try to participate in international production networks by hosting production blocks pushed out of congested industrial agglomeration in the neighborhood. During this phase, transactions by invited production blocks occur mostly in the second layer. However, developing countries that have reached a higher phase of economic development should try to formulate efficient industrial agglomeration. In this phase, transactions in the first layer become important. Alternatively, in the context of developing economies outside East Asia, long distance transactions such as those in the third layer become important. The types of expected transactions require different policies, and have different demands for hard and soft infrastructure.

International production and distribution networks, particularly at the stage of development observed in the East Asia today, present a possibility for technology transfers and spillovers. East Asia proves that the sophistication of production fragmentation can achieve the level of industrial agglomeration in which active technology spillovers may occur. In an internationally competitive environment, some MNEs are quite willing to transfer technologies. This is a new way of pursuing technology transfers and spillovers.

One problem is that not all countries can immediately attain such a stage of development. In order to participate in international production and distribution networks, a country must host the first wave of production blocks invested by MNEs. At this stage, the operation tends to be thin in value-added processes, perhaps even thinner than in the case of traditional EPZ operations, and local vertical links are not yet established. This means that significant technology transfers or spillovers may not be expected for a while if the technology absorptive capacity of the industry is not well developed. Policymakers in LDCs must be patient in hosting FDI until a critical mass is built up, rather than hastily introducing performance requirements for technology transfers. Once the seed of industrial agglomeration has been planted, local firms and entrepreneurs will have ample opportunities for penetrating production networks, which will eventually accelerate technology transfers and spillovers.

Although these arguments require further theoretical elaboration and empirical support, they seem to be largely consistent with the literature on technology spillovers, such as Lim (2007). The literature in particular suggests that vertical input-output linkages between local firms and MNEs are the most powerful channel to accelerate technology transfers and spillovers.

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